Preferred Return in Real Estate: MAXIMIZING Your Real Estate Investment
According to ZipRecruiter, the average annual pay for US real estate investors is $119,731 a year. But what if you could do better? What if you could turn your investment into a completely passive, consistently robust, and truly lifelong money-making machine?
It all starts with working with the right partners. To secure the best returns in real estate without the constant time and energy demands many active strategies require, it’s necessary to understand how preferred returns operate and which top industry professionals can help you achieve them.
In this article, we’re going to show you how to make the most of your preferred return in real estate and optimize your investments starting today, for the rest of your life.
What is Preferred Return in Real Estate?
Every real estate investment is made based on a variety of factors. In real estate investments, preferred returns represent the percentage of return of profits an investor must receive before investment managers receive their profit.
In the majority of real estate investments, preferred returns account for 6% to 9% of the return on profits. In other words, passive real estate investors are prioritized, receiving their 'cut' of investments first. This is why a preferred return is so attractive to equity investors.
If you're a real estate investor seeking lucrative cash flow, excess profits, and guaranteed payment, you want a preferred return. Take the investment advice of top property investment experts and make the most of your capital contribution.
The investment experts of commercial real estate firm, QC Capital, have delivered high returns from optimized, top-niche assets since 2019, acquiring over 500 multi-family units worth over $100 million in value. If you’re looking to maximize your returns with trusted professional management, contact QC Capital today to learn how to get started!
To receive your preferred return more quickly, you can opt for a position of preferred equity.
What is Preferred Equity in Real Estate?
Preferred equity is a position of real estate ownership in which the investor is paid back a predetermined return amount more quickly than in other ownership positions. Preferred equity is just one example of preferred return positions.
When it comes to any preferred return, there is a pecking order. There is a hierarchy of payout. Known as the capital stack, this payout order determines the payout timetable and risk-benefit analysis of all investors and parties involved.
In short, the so-called stack is the legal organization of any capital invested. For example, those at the top of the stack are taking the most risk but may expect the greatest return of capital, cash flow, and remaining sales proceeds. An investor toward the bottom may receive his or her money first but will take on the least risk and may reap the smallest reward.
Ideally, an investor wants to receive a return of capital in addition to percentage returns that are healthy and consistent. With a pref equity position, an investor can take on less risk and enjoy prioritized payout.
Preferred Equity vs Common Equity in Real Estate
Investors in a pref equity position will receive their return of capital, or principal, as well as their preferred return. By comparison, a common equity investor will receive his or her preferred return after the preferred equity investors are paid. Both common and preferred equity investors will receive their predefined percentage profits before the sponsors do.
The typical equity investment split nowadays is 70% to the limited partners and 30% to the general partner(s). Although this can vary, it usually does not vary significantly. One's position in the capital stack can sometimes make or break an investment.
Addressing Common Equity Concerns In Real Estate Investments
As a real estate investor, you should consider the relative risk and reward with which you are comfortable. When it comes to preferred and common equity, multiple investors may complicate the structure. Ultimately, you want to be treated fairly and regarded the same way as your fellow investors.
Consider a private equity contribution that matches your risk tolerance and financial goals.
In some cases, there may be only enough profit to cover a percentage of your preferred return. Ensure you do your due diligence before contributing heavily to a private equity fund. One way to achieve this would be to consult an investment specialist about the project, agreement, and profit-potential analysis.
Never enter a common or preferred equity position uninformed. Ensure your preferred return is not only robust but viable.
Why ALL Real Estate Investors Want a Strong Preferred Return
Every capital investment comes with risk. This is why preferred returns are essential to real estate investing. Not only do they entice investors, but they also ensure investors that investor capital will be used wisely, proficiently, and profitably. For example, investors are more likely to enter high-risk, high-returns property deals if they know their payday is prioritized.
Simply put, preferred returns in real estate investing are a great incentive. When making their own investment, passive investors want to know that the management team is trustworthy. Built-in preferred returns can help assuage these concerns.
Because a preferred return in real estate is predetermined, investors are unlikely to be blindsided, misled, or deceived when making their capital contributions. These established percentages help passive investors better understand the investment strategy so that they can better capitalize on investment opportunities.
Making the Most of Preferred Returns in Syndication & Crowdfunding
A real estate syndication is essentially a group of people and/or companies working in conjunction toward a common goal or objective. Real estate syndication refers to a co-investment whereby co-investors, co-owners, and/or limited partners pool their resources for a property project.
This makes it easier to pursue large investments and other investments that are too cost-prohibitive for individual investors otherwise. Common equity and capital contributions may allow investors with limited capital to enjoy lucrative income-producing assets.
A particular investor may choose to align with other investors to maximize their percentage return on leading assets. An example may be joining a syndicate for multi-million-dollar revenue streams, whether from apartment complexes, hotels, or industrial properties.
The Role of "Class A" Shares in Real Estate Syndication
When it comes to preferred returns, real estate syndication provides so-called class A shares to passive investors. Again, the average preferred return rate is 6-9%. The sponsor or syndicator managing the investment must pay this amount to all current investors before taking a cut.
Because each passive investor receives his or her percentage first, the syndicator is highly incentivized to manage and operate the investment property properly. Every investor understands this dynamic among general partners and limited partners. In other words, sponsor capital receives secondary priority.
As a result, preferred-return investments are highly attractive.
If you want a high-return threshold, great preferred returns, healthy profit splits, and reliable cash flow, you need to consider real estate syndication.
Maximizing Your Initial Investment on EVERY Investment
With the economy plummeting, every investor wants to ensure that his or her money will be secure. Fortunately, a preferred return can be largely protected, even in times of economic difficulty. If the preferred return important to you is delayed, consider the interest.
Usually, interest on a preferred return is accrued. This means that any class A shares not paid to the predetermined percentage will be paid out the following year in addition to the regularly scheduled returns. In other words, the investor would receive the accrued deficit on the previous preferred return as well as the pre-calculated preferred return for that year.
This preferential treatment of passive investors ensures that the preferred rate is preserved, even during periods of disproportionately high expenses.
Safeguarding Investments: How to Protect an Investor's Capital Account
Whether it's your first investment or your hundredth, you must always stay attuned to your initial balance, contributed capital, and cumulative preferred return rate. In some cases, shifty investors or investment managers may try to rip you off.
Not every general partner, syndicator, or investor may be trustworthy. You could lose a significant amount if you are not treated equally based on the agreement. If you are unsure about current investments or alternative investments, you should seek a leading advisor near you.
Legal documents can be lengthy and complicated. Without the proper understanding or real estate industry knowledge, you could hemorrhage money while missing out on additional profits. Contact an investment specialist about your preferred return agreement structure immediately.
Typically, these agreements follow a pari passu structure.
Understanding Pari Passu Preferred Return Structures in Real Estate
“Pari Passu” is simply the Latin term for “on equal footing". In other words, the sponsor and investors are treated equally, receiving the same preferred return until the appropriate preferred return thresholds are met.
The percentage of a preferred return in real estate typically depends on the investors involved, the quality of the investment property, and the sponsor or syndicator managing the investments. Although the average preferred return percentage is between 9% and 6%, some may vary wildly.
This all depends on the operating agreement, one of the various critical legal documents an investor in real estate must consider. To understand your potential return, you need to understand how to calculate what you may be owed at any given time.
Understanding Preferred Return: Calculated and Distributed
For example, let's say the preferred return rate is set at 7%. Once this preferred return hurdle is overcome, the payouts follow what is called a distribution waterfall. This distribution waterfall splits the payments based on the predetermined terms of the operating agreement.
One common example of the waterfall split is a 75/25 split. Once return hurdles are met, the remainder of the preferred return would be split so that investors receive 75% and the sponsor receives 25% of the return. In other words, this is the point at which the general partner can receive carried interest.
The calculation for a given preferred return amount is usually straightforward but may become more complicated on a compounding basis.
The Preferred Return Formula
Generally, the following formula is used to calculate preferred returns:
Investor Equity x Preferred Rate = Preferred Return Amount
However, this also depends on accumulations and accruals. The return can be a non-cumulative preferred return or a cumulative preferred return. If it is cumulative, then all the unpaid money earned in one period is carried into the next period.
The preferred return can also be paid based on simple or compound interest.
For example, if the return rate is 11%, but 10% is paid in a given period, the next period will pay 12% to compensate for the discrepancy.
In a simple interest calculation, the additional 1% is owed next period but not added to the investor's initial balance. On a compounding basis, the outstanding 1% is added to the investor’s capital account, increasing the next period's preferred return.
In cases where return thresholds are not met, investors and sponsors may use the catch-up provision. This provision simply states that the investor receives 100 percent of the profit distributions until the rate of return is met. Once it is met, the sponsor receives all of the profits until it is 'caught up.'
In all cases, a seasoned investment specialist can assist. If any of this is confusing, difficult, or unclear, consult a top preferred return expert near you.
Protect Your Preferred Return and Maximize Your Initial Investment
Investments do not have to be bewildering, troubling, and daunting. You shouldn't entrust your hard-earned capital to just anyone, taking chances on high-risk, low-reward ventures.
If you seek to create wealth and cash flow through dependable, powerful assets, you need a real estate investment firm you can trust.
At QC Capital, our team of commercial real estate experts has successfully acquired, repositioned, and managed complex real estate assets throughout the United States. We specialize in risk mitigation to maintain the highest level of strategic value creation.
If you're an accredited investor, do not delay. Your wealth has massive growth potential with our niche-leading assets.
Contact our expert firm and begin your journey with the right partners today.